2008 'A' Level Paper 2 Questions

Some notes:

Imperfect information and market failure

Both consumers and producers require complete information if they are to make efficient choices and decisions about what to buy and what to supply to the market.

Information failure occurs when people have inaccurate, incomplete, uncertain or misunderstood data and so make potentially ‘wrong’ choices. Sources include:

• Consumers do not have adequate technical knowledge
• Advertising can mislead or mis-inform
• Producers unaware of all opportunities
• Producers cannot accurately measure productivity
• Decisions often based on past experience rather than future knowledge

Merit/Demerit Goods and Market Failure

Merit goods	Demerit goods
Goods that society values and judges that everyone should have whether the individual wants them or not.	Goods that society values and judges to be bad for and individual
Underconsumed due to imperfect information – individuals are unaware of long-term benefits and positive externalities	Overconsumed due to imperfect information – individuals are unaware of long-term detriments and negative externalities
Consumption of merit goods is believed to generate positive externalities (MSB exceeds MPB)	Consumption of demerit goods leads to a fall in social welfare (MPB exceeds MSB)
Healthcare, education, public libraries	Alcohol, cigarettes, drugs, addiction to gambling

Merit goods provide positive externalities but if left wholly to the private sector, it is likely that merit goods will be under-consumed because individuals do not understand or appreciate the social benefits that can result from consumption of education and health services to name just two examples.

The argument concerning imperfect information is an important one. Parents with relatively poor educational qualifications may be unaware of the full longer-term benefits that their children might derive from a proper education.

Because the knowledge of these private benefits is an ongoing learning process, children themselves will tend to underestimate the long term gains from a proper education. Education is a long-term investment decision. The private costs must be paid now but the private benefits (including higher earnings potential over one’s working life) take time to emerge.

Immobility of factors of production and market failure
Factor immobility may be due to:

• Occupational immobility – this occurs when there are barriers of mobility between different jobs and different industries
• Geographical immobility exists when there are barriers to people of moving to different locations

Occupational Immobility

Occupational immobility occurs when there are barriers to the mobility of factors of production between different industries and occupations. This can lead to people remaining unemployed, or being used in ways that are not economically efficient. Land and Capital: Some capital inputs are occupationally mobile - a computer can be put to productive use in many different industries. Commercial buildings can be altered to provide a base for many businesses. However some units of capital are specific to the industry they have been designed for.

Labour as a factor of production often experiences occupational immobility. For example, workers made redundant in the sheet metal industry may possess job-specific skills that are not necessarily transferable to the growing industries in the economy. This implies that there is a mismatch between the skills on offer from the unemployed and those required by employers looking for extra workers. This is also called structural unemployment and is a major reason why there is a core of workers in the UK who find it difficult to find paid work. Clearly this leads to a waste of scarce resources and represents market failure - because social welfare is not being maximised.

Geographical immobility

There are good reasons why geographical immobility might exist:

• Family and other social ties
• Costs involved in moving home
• Regional variations in house prices
• Differences in the general cost of living between regions

The growing regional divide in house prices is a major contributor to geographical immobility. For example, the widening gap in average property prices between the north and south the UK can make it virtually impossible for people from the North to consider moving south because they cannot afford to maintain their standard of living in the South East.

Policies to Improve Mobility of Labour

To reduce occupational immobility the government might: Invest in increased provision of training schemes for the unemployed - particularly those workers experiencing structural unemployment. An example of such an active labour market policy is the New Deal : subsidise the provision of industrial training by private sector firms either through grant assistance or through tax relief . Raise total spending on education and move towards increased investment in vocational training for students

To reduce geographical immobility the government or appointed agencies might introduce reforms to the housing market designed to improve the supply and reduce the cost of rented properties. Another option is to offer specific subsidies for people moving into areas where there are shortages of labour